Frank Elderson of the ECB argues that structural fragmentation hinders the banking sector’s ability to finance Europe’s green, digital, and defense transitions.

European banks have achieved significant improvements in profitability and asset quality since the pandemic, yet structural fragmentation continues to impede their long-term competitiveness. Frank Elderson, Vice-Chair of the Supervisory Board of the European Central Bank, emphasized this dichotomy during a recent event hosted by the Hertie School of Governance in Berlin.

The sector has seen a notable improvement in return on equity, which has stabilized at approximately 10 percent. Supervisory statistics indicate that the non-performing loan ratio has declined from 6 percent in 2015 to 2 percent today. Market confidence has followed this trend, with the average price-to-book ratio for European institutions climbing toward 1.5.

Despite these gains, the fundamental issue of national market segmentation persists. Banks currently allocate roughly 80 percent of their loans to domestic households and firms, while cross-border deposit holdings remain below 2 percent. This lack of integration prevents the formation of pan-European business models capable of achieving necessary economies of scale.

Scale is essential for the heavy investments required in digital infrastructure and artificial intelligence. Without a unified market, European institutions struggle to compete with global peers when mobilizing resources for cyber resilience and innovative service development. The current environment limits the ability of banks to diversify revenue streams through cross-border mergers.

Regulatory hurdles remain a significant barrier to the consolidation of the banking sector. National supervisors often maintain distinct requirements that complicate the movement of capital and liquidity between subsidiaries within a single banking group. This friction discourages institutions from pursuing the cross-border mergers that would otherwise generate substantial cost-savings and operational efficiencies.

The current fragmentation also exacerbates the difficulty of managing risk across borders. When banks are confined to national silos, they lack the ability to diversify their portfolios effectively, which leaves them more exposed to localized economic shocks. This lack of diversification is a direct drag on profitability, as banks cannot optimize their capital allocation across the entire euro area to capture growth opportunities.

The European Union faces an investment requirement of 1.2 trillion euros annually through 2030 to meet its green, digital, and defense objectives. Private sector capital must provide the majority of this funding, as public investment alone cannot bridge the gap. Banks must operate across borders to allocate this capital where it is most productive.

Elderson advocates for a time-bound roadmap to complete the Banking Union to resolve these structural inefficiencies. Establishing a European deposit insurance scheme remains a primary requirement for creating a single jurisdiction for financial regulation. Synchronized progress on these elements is necessary to break the existing deadlock.

The shift toward strategic autonomy requires an integrated financial framework that can withstand geopolitical volatility. Relying on fragmented national markets leaves the continent vulnerable to external economic pressures. A fully integrated financial system would allow for more efficient risk distribution across the entire Union.

Deepening capital markets is equally vital for financing the transition toward new technologies and high-growth start-ups. While banks remain essential for traditional credit, equity financing is often more appropriate for innovative sectors. Advancing both banking and capital market integration in parallel will support the development of market-based financing sources.

The long-term viability of European banks depends on their ability to adapt to a digital financial system. Future success will be determined by the timely deployment of advanced technologies and the ability to serve increasingly demanding customers. Regulatory environments must evolve to enable these investments while maintaining institutional resilience.

The focus for policymakers now shifts to whether the necessary political will exists to finalize the Single Market. Upcoming milestones will likely center on the implementation of deposit insurance and the harmonization of cross-border capital flows. The ability to finance Europe’s strategic priorities rests on the success of these integration efforts.

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